At a time when insurance mandates have provoked fierce debate, the bank lobby is coalescing around an effort to continue mandatory coverage for all transaction checking deposits. But some believe such a plan is missing a key feature: choice.

The Independent Community Bankers of America and the American Bankers Association are urging Congress to extend Dodd-Frank Act language requiring participation in the Transaction Account Guarantee program. But prior to Dodd-Frank, TAG-which regulators came up with in 2008 to strengthen liquidity-was voluntary and participants were charged extra fees to opt in.

Some observers argue it's time to return to that prior model, noting that banks are split about whether to continue the TAG program, which expires at the end of this year.

A voluntary program "would certainly be a better option than just doing away with it," says Randy Dennis of the DD&F Consulting Group in Little Rock, Ark.

But the industry groups seeking an extension have resisted the idea of making TAG optional again. Paul Merski, the ICBA's chief economist, says that without across-the-board implementation, the largest banks would unfairly benefit from the "distortions of deposits shifting from smaller institutions" to those viewed as being too big to fail.

Smaller banks "that were being conservative and opted to stay in the program would be viewed as weaker in the eyes of depositors because they needed the insurance," Merski says.

The Federal Deposit Insurance Corp. created TAG in 2008 using its then-authority to provide extraordinary assistance during times of stress. The optional coverage cost 10 basis points per TAG deposit. In a later version, fees ranged from 15 to 25 basis points, based on the bank's risk profile. About 20 percent of the industry never opted into the program.

Dodd-Frank in 2010 made the coverage compulsory and set it to expire at the end of 2012. Fees were eliminated, and the FDIC covered its risk by including TAG deposits in the overall insured base.

The ICBA has been pressing for a five-year extension of the Dodd-Frank version of the coverage, which would keep the program mandatory. More recently the ABA, after hearing from members on both sides of the issue, concluded that a two-year extension was needed.

ABA Chief Economist James Chessen says an optional program poses "a big adverse selection problem" for the FDIC. "If you have 'pay-to-play', you tend to attract institutions that need the program more than others who have no interest in it. You bring in the riskiest of the pool of institutions." Then the insurance gets trickier to price, and the cost isn't spread across a broader pool of participants.

Meanwhile, banks that might otherwise find TAG unnecessary could conclude that they needed it for competitive purposes, since a bank that offered TAG could use that to market itself against a bank that did not.

"Making it voluntary runs the risk that competition will make it mandatory," says Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable.

But some say the decision of whether an institution offers deposit insurance beyond the FDIC's standard benefit of $250,000 per customer should rest with that institution, as should the decision of whether to publicize its choice.

That's the camp James Rockett, a partner at Bingham McCutchen LLP, has gravitated to after hearing from banks on both sides of the issue. "This is excess insurance above the normal limit. The marketplace would normally say: If you want excess insurance, fine, but you have to pay for that," Rockett says. "The reality is that a lot of banks would pay for it."

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Comments (1)

This is a very strange and tired debate since the FDIC and Congress intentionally restructured the original TAG program in 2010 to improve it and to make it work best by applying it across-the-board and by not allowing TAG accounts to pay any interest. TAG has been a complete success and a temporary extension is the safest and smartest policy choice at this point in such an uncertain economic environment. So no free-rides for the too-big-to-fail banks that have grown even bigger in recent years. The rating agencies state clearly in their reports how they grade these mega-banks as still having full governnment backing. With all the other "fiscal cliff" issues hanging over the nation the risks of letting TAG abruptly expire is something Congress can and must easily avoid with a temporary extension.